There are thousands of stocks to choose from, and investors can pick any company they want. Are you looking to increase your wealth through investing, but not sure how to pick stocks that will bring in the biggest profits? With stock markets nowadays offering so many options, it can be difficult trying to make smart investment decisions. It’s important that investors have a clear understanding of what factors should influence their decision-making process when picking stocks for maximum profit. In this blog post, we’ll go over some key points on how to evaluate potential investments.
Here are some considerations that may help you select stocks that are going to perform well.
1) Name Recognition & Personal Experience:
One way to get an edge is to buy stock in companies with brand recognized for quality and which you have personal knowledge of. For example, if you enjoy traveling and you stay at the well known hotel chain Marriott International Inc., and you feel their service and customer experience is good, you might consider buying their share.
The advantage of personal experience is you have an on the ground sense of whether a business is growing or not. In the case of Marriott, you can tell if there are people in the lobbies and cars in the parking lot. Leveraging your personal experience is an idea utilized by professional money managers. For example, Peter Lynch made the idea popular in his famous book One Up On Wall Street: How To Use What You Already Know To Make Money In The Stock Market. Famed stock picker Jim Kramer has also historically done on the ground research on the stocks he’s bought.
2) Profitability and Price-performance:
If you want to pick stocks for maximum profit, buy companies that have a three-year history of growth in both profitability and price.
Regarding the first point, the company really needs to be profitable. How can you tell? Well, this means it should be 1) pre-tax cash flow positive and 2) needs to have grown both its earnings per share and its post-tax profits in the past three years beyond what could be expected due to inflation. About this second point, we like to see that the price of the stock will move in tandem with its growth in profitability.
If the company is profitable, but its share price hasn’t gone anywhere in years, like Microsoft under Steve Ballmer, then it makes sense to consider other alternatives. The main idea here is that price follows earnings. The more profit a company makes the more valuable it should be, all things being equal.
3) Balance Sheet Health:
The total debt to assets ratio should be less than .5, meaning there should be 50 cents of debt, or less, for every dollar of assets. This is a must. Companies are like people, debt slows their ability to be competitive and to react to changing market conditions. Debt also reduces a company’s ability to be profitable by increasing interest expenses it needs to pay.
4) Dividends:
Your investment should make at least a small dividend payment. All things being equal, the bigger the dividend the better, provided the payments are sustainable.
Dividends do several things:
- They force company management to make good decisions. If managers know they’ll need to make a dividend payment, they’ll allocate their resources in the most efficient manner.
- Dividends are a signal of good corporate governance. Company managers can always fiddle with accounting tricks to create nominal improvements in margins, but its a lot harder to fake dividend payments. Either the money is there or it’s not.
- Dividends provide you a source of income, so you’ll get cash payments in addition to any appreciation of the stock you own.
- Dividends mean share price increases. All things being equal, dividend-paying stocks tend to outperform non-dividend paying stocks by a small margin. This is largely because their earnings are better than non-dividend stocks.
5) Smart Money Buys The Stock:
Commercially available free services such as Yahoo Finance will tell you what percentage of a company is owned by institutional investors. When selecting stocks for maximum profit, look for institutional ownership from organizations you think are smart. A note of caution here – if a company is part of an index such as the S&P 500 or the Russell 2000, then index funds will buy the stock regardless of what they think of the company. So what’s important here is which institutional investors are buying the fund. If a well regarded management company such as Dodge and Cox is buying the shares, that’s a favorable indicator.
6) Other Factors:
Of course, a ton of other factors are important; price, analysts ratings, capitalization size, industry, etc.
When its all said and done, examine the total picture and make a subjective judgment based on these criteria.
Here are more great articles on the topic of wealth building:
Nine Ways To Make Extra Money
The Pros And Cons Of Mutual Funds
What Building Seven Streams Of Passive Income Really Looks Like
Yes, You Can Buy An Oil Well
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Image source: Free Thinkers.
